The High-Stakes Fight Over How to Measure CEO Pay
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The Fiscal Times
May 1, 2014

The 848-page Dodd-Frank Wall Street Reform and Consumer Protection Act dedicates 149 words to framing a new disclosure about “pay versus performance” at public companies. Boards and management must deliver “a clear description” to shareholders of “the relationship between executive compensation actually paid and the financial performance of the issuer,” the law states.

Part 1: The Man Pushing CEO Pay to the Stratosphere
Part 2: How Smithfield Larded CEO's Pay Package
Part 3: The High-Stakes Fight Over 'Pay for Performance'
Part 4: An Unlikely Champion for Higher CEO Pay

Salvaged by Congress and the president from the greatest financial crisis since the Great Depression, the promise remains empty four years later. Nearly one-quarter of the Dodd-Frank law’s 398 rule-making requirements haven’t been proposed by federal regulators yet, according to the Davis Polk law firm’s Regulatory Tracker on financial reforms, including the expanded disclosure on performance and executive pay.

Related: The Man Pushing CEO Pay to the Stratosphere

As the Securities and Exchange Commission delays producing a new CEO-compensation dashboard, pro-business groups led by the Conference Board and executive-compensation consultant Ira Kay are campaigning to influence the definition of performance pay, and the meaning of “paid.” On April 14, six members of the Conference Board Working Group on Supplemental Pay Disclosure, including Kay, met with members of the SEC’s Division of Corporate Finance, including its director Keith Higgins and the chief of the Office of Rulemaking, Felicia Kung, according to an agency memorandum of the visit.

A recommendation shaped by Kay would ignore signing bonuses, pensions and perks — including company airplane, car, driver, club memberships and home security systems — along with out-of-the-money stock options when making pay-for-performance assessments, according to interviews with Kay and several other members of the Conference Board Working Group, and the group’s policy paper.

Under the proposed terms, three-quarters of the $15.8 million in compensation Schlumberger Ltd. awarded to Chief Executive Paal Kibsgaard in 2012 would have been excluded from his performance-pay total that year because most of the grant was tied up in options issued at a higher price than that at which the stock ended the year. Today, the same Schlumberger options would be in-the-money for about $12.5 million, lifting the cash value of his 2012 pay to $16.6 million.

The $940,201 in “above-market” interest Wal-Mart Stores credited to former CEO Michael Duke’s pension in fiscal 2014 ended in January wouldn’t count as performance pay, either. Schlumberger and Wal-Mart both are clients of Kay’s executive-compensation consulting firm, Pay Governance LLC, which advises the boards at about 10 percent of the Standard & Poor’s 500 companies.

SEC spokesman John Nester declined to comment on the Conference Board meeting or its proposals.

“This is not a piece commissioned by management or CEOs. It’s in the interests of investors and companies that are interested in these issues,” says attorney Jim Barrall, a member of the Conference Board working group, who co-chairs the Latham & Watkins law firm’s benefits and compensation practice in Los Angeles. “Clearly the agency needs to draft rules on pay versus performance. We hope they look at what we’ve done and I suspect they’re watching what we do.”

Best known for producing a widely followed consumer-confidence index, the Conference Board identifies itself as an objective, independent not-for-profit research organization “working in the public interest.” Yet its governing board of trustees is dominated by the chairmen and chief executives of global corporations. Not one member of the group’s panel on executive compensation was identified as a shareholder or independent director. Kay was its only executive-compensation consultant.

“If you’re stripping out pension valuations and other things, you’re cooking the books,” says Harvard Law School professor Jesse Fried, co-author of Pay without Performance: the Unfulfilled Promise of Executive Compensation.

Robin Ferracone, president of Los Angeles compensation consultant Farient Advisors, adds: “It will obfuscate the real relationship between pay and performance.” Ferracone co-chairs the National Association of Corporate Directors’ Executive Compensation Advisory Council, consisting of board compensation committee chairs and institutional investors. Three-quarters of NACD members surveyed last year said pay-for-performance analysis should include pension benefits, perks and other non-cash earnings, in contrast to the executive-led Conference Board framework.

Of the 250 largest U.S. public companies by market capitalization, only 37 voluntarily disclosed supplemental performance-pay tables last year, according to an analysis by compensation consultant Frederic W. Cook. Most companies stating an alternative number reported lower equity values for executives than appeared in the standard summary-compensation table, Cook found.

Enormous attention already is devoted to the summary tables in companies’ annual proxy filings. Each of eight columns tells a distinct story about CEO pay in a single line: Salary; bonus; stock; options; non-equity incentive-plan compensation; changes in pension value and other retirement savings, identified as non-qualified deferred compensation; “all other compensation,” including perquisites; and total.

The $19.1 million that Kay’s client NextEra Energy awarded to former CEO Lewis Hay in 2012 included $1.4 million in salary; no bonus but $2.6 million in tax-deductible cash incentive pay, which is otherwise equivalent to a bonus; $5.7 million in retirement savings; and $403,422 in “other compensation,” including a leased car, home security, club memberships, medical and life insurance, and personal use of company aircraft. The total also included stock and options valued at $8.9 million.

Under current SEC-reporting guidelines, the valuation of a CEO’s equity grants are about 15 months old by the time they become public. One benefit of Kay’s approach is to give shareholders a more up-to-date reading of executive pay. In years when the stock market booms, and a company’s share price rises, the market quote for a CEO’s performance pay — calculated at year end — will appear much larger. During bear markets and corporate downturns, the pay totals will appear depressed.

Under Kay and the Conference Board’s formula, NextEra would have reported $13.3 million in “realizable” pay for Hay last year, according to an analysis by Eric Hoffmann, a Farient vice president. That is much lower than the $22.7 million calculated by Farient.

Among differences, Kay and the Conference Board count the “target” value of performance shares as reported to shareholders. By comparison, Farient reports the market value of the shares as earned.

Variations in “target” and award can be significant, as the NextEra example shows. Farient pegs the market value of CEO Hay’s 166,026 performance shares earned at $11.5 million as of the last day of 2012, compared with the Conference Board’s $8 million market value of 116,193 shares targeted.

Elliot Blair Smith is a Gerald Loeb Award winner for investigative journalism and a two-time finalist. He has worked as a foreign news bureau chief in Latin America; a war correspondent in Afghanistan, Pakistan and Iraq; and now specializes in economics, finance and government policy.